Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Suggested Citation:"Economic Incentives and Clinical Decisions." Institute of Medicine. 1983. The New Health Care for Profit: Doctors and Hospitals in a Competitive Environment. Washington, DC: The National Academies Press. doi: 10.17226/527.

Below is the uncorrected machine-read text of this chapter, intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text of each book. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

Economic Incentives and
Clinic Demons
Harold S. Luft
The recent growth of for-profit activities- in medical care has led to
concern about the growth of a "new medical-industrial complex" (Rel-
man, 1980; see also Caper, 1982; Saward and Sorensen, 1982~. These
concerns range from the fear that such enterprises will skim off all
the profitable patients and leave the voluntary and public sectors with
mounting bad debts to the fear that patients will lose their trust in
the medical profession. There is also an emerging controversy over
the possibility that for-profit health care entails some economic in-
centives that may affect day-to-day clinical decisions. Will physicians
who own hospitals, laboratories, or other for-profit enterprises, or who
work for a national chain of hospitals or urgent care clinics, practice
differently from those who do not? These concerns are based on a more
general question of the extent to which economic incentives affect
physicians' decisions about patient care.
This paper is about clinical or patient care decisions, such as whether
to order an X-ray for an ankle injury, rather than about production
decisions, such as whether needed equipment should be leased or pur-
chased. No one seems to question the notion that economic factors do
(and probably should) influence production decisions, nor do people
I am indebted to Bradford Gray, Susan Maerki, Victor Rodwin, Anne Scitovsky, Jonathan
Showstack, Joan Trauner, and anonymous referees for their helpful comments on earlier
drafts.
103

104
HAROLD S. LUFT
seem very concerned about the propriety of for-profit enterprises in
this arena. Profit incentives seem to be acceptable as Tong as they are
limited to how certain services are provided and as long as the profes-
sionals who order the services and evaluate their quality are insulated
from the proprietary system. Such incentives are being questioned,
however, when they potentially affect physicians who decide what
services are needed and whether the care delivered is of appropriate
quality.
To help set the stage for a larger investigation of ethical and profes-
sional concerns about physician involvement in for-profit enterprises
in health care, this paper addresses a relatively simple question: In
the current environment, to what extent do economic or financial
incentives influence physicians' clinical or patient care decisions?
Unfortunately, physicians and economists offer markedly different
answers to the question. Unlike the situation of the 8-ounce glass
containing 4 ounces of water, the responses reflect more than seman-
tics. Physicians typically argue that such incentives have little influ-
ence, except in a few obvious and distressing cases, such as fee splitting
and kickbacks and, furthermore, that economic incentives should have
no place in clinical decisions. Economists maintain the opposite view:
Such incentives are ubiquitous and have a major influence. Some
economists would argue that expanding incentives and freeing phy-
sicians to use them would cure the ills of the medical care sector. For
instance, some economists would like to see the physician more free
to serve as the patient's agent, taking into account both the medical
and economic consequences of alternative clinical decisions. Other
economists think that a greater role of economic incentives could ex-
acerbate current problems.
Although the physicians' and economists' positions have been over-
drawn for the sake of exposition, the perceptions are so divergent that
an examination of the models of clinical decision making used by the
physician and the economist is warranted. The differences in these
models partially explain why the answers to the simple question of
the influence of economic incentives are so divergent. The following
section reviews the evidence on the effects of economic incentives on
physician behavior, prefaced by a discussion of what is considered
acceptable evidence by physicians and economists. The third section
offers a synthesis ofthe two views, suggesting how economic incentives
can have an important role in decision making despite being invisible
to the clinician. A final section provides a brief summary and conclu-
s~ons.

Economic Incentives and Clinical Decisions
105
Models of Clinical Decision Making
The usual medical mode! of decision making involves a complex and
largely intuitive process whereby the physician considers signs, symp-
toms, and a variety of test results and, based upon scientific knowledge
and clinical experience, arrives at a diagnosis and chooses the best
treatment (Eddy, 19821. The classic biomedical mode} presumes a sin-
gle, potentially identifiable cause of a disease for which there is a
single best treatment. Only in recent years has the existence of mul-
tiple factors in the causation of disease been recognized by some phy-
sicians, along with the recognition that patients may differ in their
preferences for or responses to alternative treatments for the same
condition (McNeil et al., 19821. The traditional, reductionist single-
cause/single-cure model, which long has been at the root of biomedical
research and medical education, makes the physician a seeker oftruth,
who must vigorously resist any deviation from the one right path, for
economic or other reasons. This model of behavior has other important
implications. The physician is clearly in authority, and the patient
must wait to find out the correct course of action. The authority of
the physician also implies the responsibility for making the correct
diagnosis and for choosing the correct treatment. The implicit re-
sponsibility probably contributes to the large volume of malpractice
suits.
Diagnosis and treatment decisions often are not clear-cut. However,
in practice, many physicians act as if things were clear-cut and develop
"standard operating rules" or "clinical policies" that dictate what should
be done (Eddy, 1982~. These clinical policies may be highly complex,
such as: "If signs A, B. and C are present, test X is negative, and there
is no history of Y. the appropriate diagnosis is Q and the treatment
is R." Furthermore, as will be seen below, experienced physicians may
often have different clinical policies. Some physicians, trained in the
techniques of decision analysis, argue for the explicit consideration of
alternative causes and treatments (McNeil and Adelstein, 1975; Pau-
ker and Kassirer, 19751. Explicit choice making, however, highlights
the uncertainties in medicine that the typical physician would often
rather ignore. For example, suppose that the available information
allows the physician to reduce the problem to the following: "Every-
thing points to the conclusion that the patient has disease Q and the
appropriate treatment is R. but there is ~ chance in 100 that it is
disease S and the treatment should be T." Most physicians seem to
prefer not to deal explicitly with the probabilities and potential out-

106
HAROLD S. LUFT
comes, Instead focusing on statements such as: "In my experience the
problem seems to be Q. and the correct treatment is R." Because most
such clinical policies are based on extensive experience and the de-
cisions generally are accepted by the patients, the results usually are
not substantially different from what would be found after a careful
decision analysis exercise. And the physician usually sleeps more
soundly by ignoring the overwhelming number of implicit probabili-
ties, valuations, and choices that arise each day.
In contrast to medical training, which emphasizes the single best
course, economists are trained to believe that there are an infinite
number of potential solutions, the selection of which should depend
on individual preferences, and that the most efficient allocation of
resources will be achieved if everyone pursues his or her own self-
interest in a market economy. Furthermore, although physicians have
traditionally seen medical problems in terms of immutable laws of
chemistry and physics, economists have been expanding the realm of
economic analysis, with its emphasis on individual choice and trade-
offs, to include politics, the family, and natural selection (Becker, 1981;
Wilson, 1978~. (The holistic approach in medicine takes a much wider
view and recognizes the importance of multiple factors, but it is still
far from the mainstream.)
This difference in perspective has clear implications for the way
that economic incentives are perceived. Under the traditional physi-
cian mode] the medical problem and its potential solutionsis dealt
with independently from all else. Moreover, although the physician
is primarily concerned with the patient's well-being, the evaluation
of what is best is usually from the perspective of the physician rather
than the patient. The extreme economic view is to include everything
in the choice set. For example, Grossman's mode} of the demand for
health views the body as a machine that depreciates yearly until it
breaks down and is overhauled (medical intervention) or scrapped
(death) and for which preventive maintenance decisions are consid-
ered relative to other ways that the owner can spend his or her time
and money (Grossman, 1972, 1982~. From the economist's perspective,
physicians are like auto mechanics, who want to turn every ordinary
family car into a luxury machine without considering whether the
family would like to spend its time or money on something else, such
as a summer vacation.
The analogy to an auto mechanic may distress some physicians, but
it incorporates the economist's recognition that many of the technical
details of medicine are too complicated for patients to evaluate di-
rectly. However, just as few consumers understand the complexities

Economic Incentives and Clinical Decisions
107
of auto repair, although most can determine whether a car is running
better, patients often can evaluate the results of medical care without
understanding the disease processes or the therapeutic alternatives.
The problem for the patient is to have someone determine what is
wrong, to have the treatment choices identified and explained, and to
choose the appropriate people to carry out the desired interventions.
In this regard the economist views the ideal primary care physician
as the patient's agent, providing the relevant information and select-
ing the appropriate specialists (Feldstein, 1974; Pauly, 19801. (Note
the parallel to a trusted mechanic who can diagnose a transmission
problem and then identify a competent specialty shop to do the work.)
A perfect physician-agent would lead the consumer to precisely the
same decision as the consumer would have reached given all of the
physician's expertise. This decision may well differ from traditional
"best medical practice" because the patient is likely to take into con-
sideration the cost of the services, the time involved in treatment, and
other factors not usually involved in choosing the best medical out-
come.
Although the notion of a perfect agent is a very attractive theoretical
concept, there are few perfect agents because of the conventional meth-
ods of organizing care and paying physicians. It is often the case that
most of the work is in arriving at the diagnosis, so the same physician
provides both the diagnosis and the treatment. The dominant mode
of payment is fee-for-service, and, more important, fees are heavily
weighted toward laboratory tests and diagnostic and therapeutic pro-
cedures in contrast to time spent talking with the patient (Schroeder
and Showstack, 1978; Showstack et al., 1979~. The hypothetical "phy-
sician as a perfect agent" would be available and willing to spend
time with the patient, investigating the problem, pondering the di-
agnosis, and calculating the alternatives. The best physician-agent
would have no personal economic incentives either to encourage or
discourage additional tests and procedures or to prefer one course of
treatment over another. In practice, however, except for psychiatrists,
fee-for-time arrangements for physicians are uncommon.) Further-
more, primary physicians are rarely only counselors, and even the
diagnostic function involves many highly profitable tests.
The crucial issue here is not the method of paying the physician-
fee-for-service, capitation, or salary but the linkage between the
Surgeons often charge a fee that includes pro- and postoperative visits, obstetricians
have prenatal/maternity packages, and pediatricians sometimes have a single fee for the
first year of well-baby care. In most of these cases, however, tests and treatments for
complications are handled on a standard fee-for-service basis.

108
HAROLD S. LUFT
physician as agent and the physician as provider. For instance, many
medical school faculty are on a straight salary, yet they know that
their department's revenues are dependent on fee-for-service billings
and that a revenue shortfall will affect salaries, promotions, and per-
quisites. Similarly, the medical group in a health maintenance or-
ganization (HMO) may receive a capitation payment covering the
annual primary care of its enrollees, but if the group orders too much
hospital care, its share of the plan's net income will be smaller (Luft,
19811. The incentives to provide services are reversed in some sys-
tems fee-for-service has a bias toward more services while the fixed
budget of a HMO sets up a bias toward fewer services but in each
case economic factors are present that could influence clinical deci-
sions. Whether physicians respond to such incentives is another ques-
tion.
Incentives from the Perspective of the Physician and the
Economist
Before reviewing the evidence concerning the role of economic incen-
tives, we must consider what would be recognized as an "influence on
clinical decisions." Although the medical literature generally ignores
the possibility of such influences, when they are discussed, it seems
to be in terms of conscious behavior on the part of the physician. For
instance, physicians in prepaid plans have identified as an advantage
the fact that all their patients have comprehensive coverage, so the
physicians need never be concerned that a proposed treatment would
bankrupt the patient (Cook, 19711. Clinicians in fee-for-service prac-
tice have mentioned being aware of the gross revenues associated with
a procedure while making clinical recommendations (personal com-
munications). Most physicians, however, seem to claim that financial
incentives do not influence their patient care decisions.
Economists take a much broader perspective, and, although their
language may suggest conscious decision making, they typically care
little about what people say they do (or why they do it), focusing their
attention instead on behavior. if financial incentives would reward a
certain behavior, everything else being equal, then if the behavior is
observed, the role of incentives is deemed empirically supported. In
this type of analysis the economist typically ignores (or attempts to
hold constant statistically) all but the economic variables such as
prices and incomes. It is understood that in any particular case, clin-
ical, personal, professional, or other factors may be present and even
dominant, but such factors are seen as essentially random. That is, if

Economic Incentives and Clinical Decisions 109
one considers a large number of cases, these noneconomic factors will
cancel out, leaving one able to observe the pattern left by the consis-
tent impact of economic incentives. By contrast, the clinician is trained
to focus on precisely those noneconomic factors that the economist
dismisses as random and will believe and argue that each case is
handled individually, with attention only, or almost only, to the clin-
ical problem. It may be the case that 95 percent of the decision is
based on clinical factors and 5 percent on economic factors. The phy-
sician will fee] that the economic factors are inconsequential, and the
economist will respond that if one examines many similar cases, ab-
stracting from the random clinical factors, economics dominates and
patterns emerge that cannot be explained by clinical factors.
Yet another difference in approach helps explain the different per-
ceptions of the economist and the physician. The economist tends to
be denominator oriented, focusing on the influence of economic var-
iables on various decisions, such as whether individuals experiencing
a given set of symptoms decide to see a physician. The physician is
typically numerator oriented, focusing on persons who come to the
office for care. The physician notes that fees do not influence his or
her patients, although the economist responds that fees will determine
(at least in part) how many people decide to present themselves as
patients.
In most instances the economist attempts to demonstrate a statis-
tically significant effect of an economic variable. The interpretation
of such a finding is generally open to question on two grounds. The
first is whether the observed correlation really implies causation or
whether other, unobserved factors may be causing the measured re-
lationship. The second is whether the statistically significant effect is
substantively important. Large samples and sophisticated economet-
ric models often allow very small effects to be measured, but such
differences may be of no policy import. From the physician's perspec-
tive, subtle tendencies, regardless of the statistical significance or
aggregate importance, are inconsequential unless one can identify
clear instances in which the economic incentives can be shown to have
led to an altered clinical decision. Given the different orientations and
tools, the physician's microscope and the economist's telescope, it is
not surprising that the two cannot easily agree on what evidence is
appropriate. Largely because physician-researchers have not consid-
ered the role of incentives a fruitful research area, most of the avail-
able evidence uses the economist's approach of searching for tendencies
across large numbers of cases. There are, however, a few exceptions
that are clinically oriented.

110 HAROLD S. LUFT
Economic incentives can potentially influence clinical decisions in
a wide variety of ways, and it may be useful to consider two broad
categories that may bear on subsequent discussions of for-profit en-
terprise in health care. The first type of incentive or situation involves
the physicians' ability to hire other workers (and equipment) and to
make more money by owning a larger enterprise. Although the di-
viding line is not clear, most would perceive a qualitative difference
between a physician who hires a nurse practitioner and one who runs
a chain of weight reduction clinics. At one end of the spectrum the
physician is still primarily a clinician but one who must give some
attention to the economic realities of his or her practice. At the other
extreme the physician is primarily a business-operator with little day-
to-day clinical involvement. The second category of incentives pertains
to the way the physician is paid for patient care activities. This in-
cludes methods such as fee-for-service, salary, or prepayment with
physician responsibility for the costs of prescribed services. It also
includes the incentives inherent in each type of payment system, such
as relatively higher fees for procedures and tests compared with pay-
ment for the physician's time.
Incentives and the Use of Technology
Much of the rapid growth in the use of various medical technologies
may stem not just from their clinical efficacy but also from the high
returns physicians can get by using such technology. A primary care
internist can increase his or her net income by a factor of almost three
by prescribing a wide but not unreasonable set of tests (Schroeder and
Showstack, 19781. The term not unreasonable is a reflection that the
use of such tests is so common as to be almost standard practice; yet
some clinicians would argue that few of the tests are actually nec-
essary (Griper et al., 1981; Martin, 19821. Some diagnostic technol-
ogies, such as endoscopy, have been studied in detail. They are highly
profitable, have proliferated rapidly, yet rarely result in a definitive
change in treatment outcome (Showstack and Schroeder, 19811. Is this
evidence of economic incentives influencing practice patterns? From
the economist's perspective, the answer is yes, but the clinician might
quickly point out such factors as the low risk of the procedure and the
importance of the reassurance it can provide to the patient (and the
physician).
A study by Childs and Hunter (1972) of diagnostic X-ray use pro-
vides an example of the role of multiple factors in clinical patterns.
They examined the use of X-rays for persons under old-age assistance

Economic Incentives and Clinical Decisions
111

112
HAROLD S. LUFT
Payment and Practice Setting Incentives
In contrast to the near dearth of studies on incentives and technology,
there is considerable evidence concerning the role of direct payment
incentives and practice patterns. The clearest distinction is between
physicians paid on a fee-for-service basis, in which case there is a clear
incentive to do more, and those paid a fixed sum in salary or capitation.
Bunker (1970) found that certain discretionary surgical procedures
were performed twice as frequently per capita in the United States
as in England and Wales. Although the difference in mode of pay-
ment fee-for-service in the United States and salaried in Britain-
might explain this difference, the number of surgeons in the United
States was also proportionately higher. International comparisons are
fraught with difficulty, so studies of different practice settings within
the United States may be more conclusive.
In almost all comparisons of persons enrolled in HMOs of the prepaid
group practice (POP) type and those obtaining care in conventional
fee-for-service settings, the hospitalization rate for the HMO enrollees
is lower (Luft, 19811. There is some evidence that people who switch
into PGPs from conventional plans have previously been lower uti-
lizers of hospital care than those who do not switch into a PGP (Berki
and Ashcraft, 1980; Eggers and Prihoda, 1982; Luft, 19811. Despite
this, the average PGP enrollee is not noticeably more healthy than
enrollees in conventional insurance plans (Blumberg, 19801. (This is
possible because relatively recent enrollees make up only a relatively
small proportion of PGP members at any point in time.) Therefore, it
is unlikely that differential health status accounts for all the observed
differences in hospitalization rates between enrollees in conventional
plans and prepaid group practice HMOs (Luft, 1981~. However, the
observed differences in hospitalization rates do not necessarily reflect
physicians' decisions whether to treat patients. Some of the changes
in utilization rates reflect differences in the ways that treatments are
provided. For instance, the design of most PGPs involves comprehen-
sive coverage of diagnostic services in and out of the hospital, incen-
tives to reduce hospital use, and physically convenient ambulatory
facilities. Thus, for example, patient stays may be shortened by having
the patient arrive the morning of the operation rather than the night
before. Similarly, Kaiser-PortIand reports that 35 percent of all its
operative procedures were performed on a come-and-go basis, i.e., in
the operating room but without a hospital admission unless compli-
cations occur (Marks et al., 19801. Such practices are becoming in-
creasingly common in the fee-for-service sector, but the different

Economic Incentives and Clinical Decisions
113
incentives in prepaid and nonprepaid settings may explain why this
cost saving technique was more quickly adopted by HMOs (Lavin,
1982~. More important, things such as ambulatory diagnostic work-
ups, same day (come-and-go) surgery, and come-and-stay surgery (i.e.,
the patient is admitted on the day of the operation) really involve
minimal changes in clinical practice; they are primarily production
process decisions concerning the most efficient way to carry out a
specific task.
Another issue to be considered in the HMO studies is the extent to
which differences may be attributable to group practice, rather than
to the economic incentives resulting from prepayment. The relative
performance of independent practice associations, which involve some
financial risk sharing by independent, primarily fee-for-service prac-
titioners, is much less impressive than that of PGPs (Luft, 19811. On
the other hand, some fee-for-service groups seem to have hospitali-
zation rates for their patients comparable to those of prepaid groups
(Broida et al., 1975; Nobrega et al., 1982; Scitovksy, 19811. Why this
is the case is not clear, but speculating on the cause may help clarify
the different perspectives physicians and economists have on the role
of incentives.
One explanation that has been offered for the low hospitalization
rate in certain group practices is that the number of specialists relative
to generalists is so low that the specialists are occupied with clearly
necessary admissions and do not have time for the more discretionary
cases. This implies that different decision criteria are used, such that
the same patient would be treated differently by the specialist in such
a group than by a similar specialist in solo practice. If solo practi-
tioners are less busy (in general this is the case, with surgeons pre-
ferring to do more procedures than they actually do), then their patients
may have more extensive tests and workups, followed by hospitali-
zation. By contrast, the patients in a group setting might be more
likely to be told to monitor the condition over the next few months,
and, if it does not improve, more aggressive treatment will be under-
taken.
Notwithstanding the differences in hospitalization, patient out-
comes in both styles of practice may be similar because many medical
problems are self-limiting. Practitioners in both settings see their own
practice styles as clinically successful. But one may ask: If both the
solo and group physicians are in a fee-for-service environment, why
do they not develop similar practice patterns? Put another way: What
prevents the group practice from adding more specialists who, pre-
sumably, would do more discretionary procedures?

114
HAROLD S. LUFT
We must now move back from the economist's mode] to something
closer to clinical practice. Procedures often seen as discretionary, such
as cholecystectomy, hysterectomy, and hemorrhoidectomy, are prob-
ably seen as more mundane and less challenging if only because they
are so common and the patient is not in a crisis situation. If the
specialists can keep busy with interesting cases by limiting the num-
ber of physicians in the group, then they probably will do so, rather
than expand the group just for the sake of bigness at the cost of diluting
the clinical case mix. (Note that if the group expands by adding pri-
mary physicians and thus enlarges its patient base, dilution is not an
issue.) Although this scenario is plausible, one should note that the
empirical base for these observations is extraordinarily thin, being
limited to a handful of studies focusing on large, well-respected mul-
tispecialty group practices, often with large numbers of referral pa-
tients, such as the Mayo Clinic. Specialists in such settings may well
establish rather stringent criteria for hospitalization because they
have so much experience with sicker patients.
The notion of different criteria for hospitalization is very close to
our original question about the impact of incentives on clinical deci-
sion making. Observational studies suffer from an inability to control
for case mix, so the standard retort to the differences between HMO
and fee-for-service settings is that in some subtle way HMO enrollees
were healthier at the outset. HIatky et al. (1981) undertook an im-
portant, although limited, study that controls for this problem. They
sent a series of case histories of patients with various types of heart
problems to a sample of board-certified cardiologists. Each physician
was asked a series of questions about how he or she would manage
the case and, in particular, whether certain diagnostic tests or bypass
surgery would be recommended. Physicians in independent fee-for-
service practice were significantly more likely than those in a prepaid
group practice to recommend the tests and surgery. This finding sup-
ports the notion that clinical decision-making patterns in prepaid
groups are different. Interestingly, the recommendations of the HMO
physicians were similar to those of university cardiologists, making
it more difficult to say that the POP practice pattern represents in-
ferior care. As has been noted, one cannot separate the prepayment
from the group practice effects. More important, as we will soon dis-
cuss, the data do not indicate why or how the difference occurred.
Incl:ividual versus Collective Patterns of Practice
This brief review suggests that, despite the physician's general view
that economic incentives do not influence clinical decisions, various

Economic Incentives and Clinical Decisions
115
bits of evidence at least are consistent with the notion that economic
incentives do have an impact. The physician's perspective may be
based largely on the absence of incentives in a conscious choice process.
Most clinicians develop preferred ways to handle particular clinical
situations and, when presented with a case, may not give much thought
to alternatives or at least to the role that nonclinical factors, such as
price, might have on the selection among alternatives. This section
will take the issue one step further, to examine whether the influence
of such incentives seems to result in clinically inappropriate choices.
After all, the concerns about for-profit enterprises in medicine stem
largely from the notion that care will suffer.2 The first step in this
examination is the recognition that medicine abounds with situations
in which alternative clinical strategies are available with no scientific
evidence indicating which is preferable. The second step is the rec-
ognition that despite this physicians may have strong preferences
concerning these alternatives and that there may be a correlation
between economic incentives and these preferences.
A careful review of the medical literature indicates a wide range of
situations in which adequate scientific evidence does not exist to es-
tablish one treatment as definitively superior. For instance, Wennberg
et al. (1980) found substantial controversies surrounding nine common
surgical procedures. A great debate continues over whether certain
types of coronary diseases are best managed surgically or medically
(Carr et al., 1982; Mcintosh, 19811. Yet in each situation individual
physicians tend to prefer and to use one mode of treatment and do not
behave as though there is a gray area that research evidence does not
resolve.
Definitive clinical trials to narrow the gray area are extremely
difficult and costly because the patient's outcome in any particular
case is dependent on a host of factors in addition to the one under
consideration. (Even major clinical trials often provide ambiguous
results.) Thus, very large samples and sophisticated methods may be
required to determine the specific gray area situations in which treat-
ment A is superior to treatment B. Individual clinicians cannot un-
dertake such studies in a systematic way. Yet many act as if the
evidence were clear. ~ think the reason for this is threefold. First,
medical training generally lacks training in research design, epide-
2Another concern is that the rise of for-profit enterprises in medicine will change the
physician's perceived role so that it will no longer be that of a professional. This may entail
a loss of prerogatives, status, and credibility. Furthermore, to the extent that the physician's
credibility has a beneficial placebo effect on the patient, the loss of status may indirectly
affect patient outcomes.

116
HAROLD S. LUFT
miology, and other analytic methods. Case reports and uncontrolled
trials abound in the medical literature (McKinIay, 19811. Second, re-
ports of new techniques are generally offered by their innovators, and
the early "evaluation" is usually done by strong advocates of the tech-
nique. Although this may not lead to intentional bias in the results,
various studies indicate that subsequent controlled trials often are far
less supportive of the technique. (It is important to note that in most
cases the technique is not found to be worse than the alternative, only
not superior; i.e., it is in the gray area.) Third, although the medical
literature offers little useful guidance, the practitioner constantly makes
ad hoc observations that tend to support and reinforce whichever view
is initially held.
Suppose the decision concerns a service that, given the available
research, is truly in the gray area, such as bypass surgery for two
diseased coronary arteries. For more severe disease there is clear
evidence of improved survival with surgery, but the available studies
are less clear for intermediate levels of obstruction. Survival rates for
medical and surgical management are roughly comparable. While
death rates tend to be low for both treatments, the morbidity (and
costs) associated with each method differs. A physician choosing one
method will tend to focus on the good outcomes, recalling that the
failure rate is really no higher than for the alternative. Because pa-
tients' beliefs often are significant factors in improved outcomes (viz.,
the placebo effect), a physician who strongly recommends one alter-
native as being "superior in my experience" may well be correct be-
cause of the expectation of improvement. More important, those patients
who demand a careful evaluation of the alternatives are likely to lead
their physicians to react in one of two ways.3 If they eventually follow
their physician's recommendation and do less well than might be
expected, their poor outcome may be blamed on insufficient trust, and
the physician's preferences for not giving the patient explicit choices
will be reinforced. This is often referred to as reducing cognitive dis-
sonance. (If they do well, it merely confirms the physician's original
view about the correct treatment.) However, some patients will decide
against the recommended alternative and will change physicians,
3Some physicians encourage patients to ask questions and make choices; the increased
control their patients experience may actually result in better outcomes. Careful studies
of this hypothesis are not available. As has been noted earlier, this model of patient decision
making reduces the physician's power, takes more time, and may be perceived as more
risky. Moreover, it is probably the case that some patients want their physicians to make
all the choices, although others want the reverse, and this, too, may result in self-selection
(O'Donnell, 1982).

Economic Incentives and Clinical Decisions
117

118
HAROLD S. LUFT
recommended surgery for patients with left main artery and triple
vessel disease, a recommendation clearly supported by the research
literature. The variability was concentrated among the less severe
cases in which the research is not definitive, further supporting the
notion of differences in the gray area.
Although the wide variation in patterns within practice settings
may have idiosyncratic origins, such as the teachings of an influential
professor or a memorably bad experience with an alternative strategy,
there also seem to be consistent patterns of care related to the method
of payment and other economic incentives. The reasons for a statistical
relationship between economic incentives and practice patterns are
not well established. Two explanations may be offered. First, it may
be that economics directly shapes the clinical patterns, so that, for
example, a new physician, even one trained in a conservative, watch-
and-wait style, who enters fee-for-service practice quickly recognizes
that the loan will not be paid off and the yacht will be long in arriving
unless he or she does more tests and procedures. (One can describe a
counter example for a new partner in an HMO.) This explanation is
incorporated in much of the rhetoric about fee-for-service and prepaid
systems, but it rarely is reported by physicians in those settings.4
The second explanation focuses on the selection behavior of patients
and physicians. Just as patients select a physician they think will
provide the advice they desire and with whom they feel comfortable,
physicians select practice patterns. By the time residency is completed,
an aggressive physician probably knows an HMO is not the most
conducive setting for that style of practice. In many cases choice may
not be conscious. Such a physician's mentors are much more likely to
be in a fee-for-service setting, and the new physician's perception is
merely of following a style that clearly works. Likewise, a conserva-
tively oriented physician may find the HMO environment more com-
fortable. Decisions of this type may be made primarily on the basis
of collegial support; it may be difficult always to be different in one's
clinical recommendations. Economic incentives probably also have a
more direct influence, even if not influencing clinical decisions. Given
the current structure of medical fees, a conservative practitioner in a
fee-for-service environment will typically earn less than his or her
Occasional stories of this type do appear, but they seem limited to Medicaid mills or
other extreme settings. There is certainly not enough evidence of this type to explain the
different practice patterns in large, mature HMOs such as Kaiser and Group Health Co-
operative. The truth may be concealed because such a gross influence of economic incentives
runs counter to the hallowed view of medical ethics. However, given the emotionally charged
debates in this area, if this were a common problem one would have expected more evidence
to have surfaced.

Economic Incentives and Clinical Decisions
119
peers, so a switch to an HMO setting might be attractive because less
use of expensive services might yield a larger year-end bonus.
The selection hypothesis also helps explain the observed positive
correlation between the supply of surgeons and the incidence of sur-
gery without resorting to a crude demand-generating mode] (McClure,
19821. If physicians have some implicit income target, this income
level can be reached by aggressive practitioners with a small but
intensively treated population base or by conservative practitioners
with a larger and less intensively treated population.5 This could
result in a natural sorting process through which areas happening to
have conservative practitioners are in equilibrium with low-intensity
care, while areas with aggressive practitioners reach an equilibrium
with high-intensity care. Of course, such a situation requires con-
sumer insensitivity to costs (a result of extensive third-party coverage)
and lack of knowledge or relative indifference to alternative treatment
options. This brings us back to the question of the effectiveness of the
physician as the patient's agent. However, it is important to recall
that as long as we are discussing decisions in the gray area, individual
physicians may firmly believe that they are following appropriate
practice and that this has nothing to do with economic incentives.
Furthermore, most clinicians appear to be unaware of costs or to be-
lieve that a third-party payer, not the patient, will foot the bill.
Summary and Conclusions
Much of this paper has been devoted to an attempted reconciliation
of the apparently opposing opinions of physicians and economists con-
cerning the influence of economic incentives on clinical decisions. Dif-
ferent approaches to empirical research and different criteria for
acceptable evidence are partial explanations of the different percep-
tions. Perhaps snore important is the central role given choice and
adjustments at the margin in the economist's world view and the
tendency by clinicians to view a problem as a challenge to find the
one correct solution. Given such widely divergent starting points, it
is difficult for economists and physicians to agree even on terminology
and to discuss their differences without becoming convinced the other
is totally missing the point.
On the empirical side, there is certainly evidence concerning the
5The target-income hypothesis is hotly debated by economists who seem unable to reach
a definitive conclusion on this issue yet continue to hold strong beliefs about it. Gray areas
exist in medical economics as well as in medicine. See Fuchs and Newhouse (1978), Hixon
(1980), Richardson (1981), Wilensky and Rossiter (1981).

120
HAROLD S. LUFT
adoption and use of medical technology and different practice pat-
terns that is consistent with the notion that economic incentives
matter. Such evidence may be sufficient to convince the economist
that we should examine the effects of the types of economic incentives
created by different types of practices and payment settings, but it
lacks the power of a randomized controlled trial to convince skeptical
physicians. One of the difficulties is that from the clinician's per-
spective the observational studies are missing an explanation of how
economic incentives alter practice patterns, particularly when they
do not see such factors playing a role in their own experience. A
possible explanation for both sets of evidence is that there is often a
wide range of acceptable clinical practice, even though each clinician
may believe in his or her own way. If clinicians sort themselves into
different practice settings whose economic incentives are consistent
with aggressive or conservative practice styles, we will observe clinical
patterns that appear to be shaped by economics, although the clini-
cians themselves see no such effects.
The foregoing is a description of a relatively slow and passive pro-
cess. Morever, because the medical care market has been relatively
noncompetitive, there has been little active encouragement to the
sorting out of physicians, let alone the evaluation of alternative clin-
ical approaches. The gray area often is wide, but there has been rel-
atively little exploration of how wide it might be. The situation is now
beginning to change. More and more studies are being proposed or
undertaken to evaluate new technologies (Bunker et al., 1982; Green-
berg and Derzon, 1981; Towery and Perry, 19811. Simultaneously, the
growth and development of HMOs, for-profit hospitals, health care
corporations, and other organized systems provide both the means and
incentive to evaluate the alternative clinical strategies in cost-effec-
tiveness terms. This may lead to more active efforts by such organi-
zations to use incentives or pressures to get their clinicians to alter
their practice patterns. Some physicians already are beginning to view
the world through the economist's eyes and to use the language of
choices, trade-offs, and financial transactions (rein, 1982~. Whether
such changes are desirable is a much larger question, but there can
be little doubt that they are occurring.

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